Tuesday, October 7, 2008

A Short Update

In keeping with my observation that the folks in charge of keeping the markets safe for investors have decided it's unimportant that sellers actually deliver anything to buyers, I thought I'd point out the current short interest in a few issues I watch:

% of
Float_____Symbol and Name of Issue______Market Cap
===== ___===================_____=========
56.81%____SHLD - Sears Holdings Corp.___$11 Billion
27.34%____CDS - China Direct Inc._______$0.1175 Billion
19.16%____ACAS - American Capital Ltd.___$4.6 Billion
14.66%____AGNC - American Capital Agency $0.238 Billion
10.94%____AINV - Apollo Investment Corp. $2.0 Billion
_3.50%____GS - Goldman Sachs Group Inc. $47.5 Billion
_2.92%____AAPL - Apple Inc.__________$93.2 Billion
_2.80%____GOOG - Google Inc._________$119.8 Billion
_2.38%____MKL - Markel Corp._________$3.2 Billion
_1.09%____IBM - Int'l Business Machines Corp. $155.1 Billion
_0.78%____MSFT - Microsoft Corp._______$228.3 Billion
_0.24%____BRK.A - Berkshire Hathaway Inc. $207.3 Billion

First: The meme that has shorts descending like locusts on innocent companies and crushing them for the marrow of their bones needs some elaboration. Crushing high-fliers seems to work best when share overhanging the market are modest enough in size that shorts can create enough near-term impact to inspire real investors to notice the selling and respond (or, have their good-'till-cancelled stop-loss orders respond). Moving the share price of a hundred-billion-dollar behemoth with sizeable trading activity is much harder than attacking a thinly traded issue, or an issue with an enormous market capitalization.

Second: In a company with over five or ten percent of its entire outstanding float short, what's the chance most of that short interest has actually delivered the shares? A look at the Regulation SHO lists confirms that the heavily shorted issues are also failed-to-deliver issues. A requirement for actual delivery of securities would offer some meaningful limitation of short activity -- by creating demand among shorts for possession of borrowable certificates, and thus adding value back to the market shorts artificially depress by expanding supply -- and limit the opportunity of shorts to manipulate the market by effectively issuing new shares from which the issuer derives no benefit (only detriment).

Under the SEC's who-cares attitide toward share delivery, I've begun to wonder whether I'm in the wrong business. Imagine you could sell goods all day long from an empty inventory and never get caught? I mean ... who wouldn't play this for all it was worth?

This means that if you went to all the people who thought they owned shares of Sears, and you bought their interest (nevermind that Eddie Lampert wouldn't part with his without charging a pretty penny; he'd wait until you've bid up the shares, then he'll want a control premium), they'd purport to sell you 156.81% of the outstanding shares of SHLD. Of course, that's impossible to own, as the most you can own of any corporation is 100% of its outstanding stock. That is, you know, part of what it means for stock to be outstanding. If it's not part of that 100% oustanding, it hasn't been issued. And that's what non-delivering sellers are peddling: "shares" that haven't been issued. Interestingly, the extra 56.81% created by shorts is enough to mess up the voting and control of a corporation pretty badly. To whom to you send materials in a proxy fight? Not to the guys who didn't get delivery, I imagine -- and if that's you, you've been deprived of your right as a shareholder to have your say on shareholder matters. Given that shareholders haven't a statutory right to profits or dividends, but only to vote their shares, this is basically a complete deprivation of one's rights as a shareholder.

Normally as you short shares, you expect to have to borrow the shares from someone. This way, you owe someone the shares, and you have something to deliver a buyer. The buyer doesn't know about your lending arrangement with the shares, and he doesn't care: he has the certificate and he's taken care of. As shares are accumulated by someone who isn't lending them out, it becomes harder to find shares to borrow. As certificate-lenders sell their shares they require their borrowers to replace them -- to cover the short -- and as buyers do things like request certificates to be delivered and enroll in company-run DRIPs that don't lend shares, the shares get harder to borrow. If short interest is especially vigorous in a security, it might also get hard to borrow the shares, making short positions hard to establish during a collapse.

The interesting thing is that, because sellers aren't required to deliver the shares, there's no-one to force shorts to cover as the certificates of owners are requested for delivery and stop being available to borrow for short sales. This means that as you buy up shares from people who have certificates, you eventually have two kinds of people: you (who hold the share certificates) and dupes who think they hold securities that they paid for but were never delivered, because the seller never figured out who's certificate he was going to deliver.

One thing I notice is that companies with lower market capitalizations (SHLD has $11Billion in market cap at present, and ACAS $4.6Billion) seem easier to drive down with high short interest than companies that have larger market caps, like Berkshire Hathaway. But have I got it wrong? But for the extra shares created by shorts -- the marginal 56+% -- might SHLD have a rather different market cap? The principles of supply and demand certainly suggest it.

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